In a groundbreaking Wall Street Journal article to be published in tomorrow’s newspaper, Berkshire Hathaway Vice Chairman Charlie Munger all but confirms that Li Lu will become one of Berkshire Hathaway’s top investment managers. We have previously covered Li Lu on The Rational Walk and recently posted a video of a presentation he gave at Columbia Business School outlining his investing philosophy. At the Berkshire Hathaway annual meeting in May, Mr. Munger made a vague reference to one of Berkshire’s investment manager candidates who returned 200 percent in 2009. Many believed that he was referring to Li Lu.

Munger’s $88 million Investment

The Wall Street Journal article includes information that has not been previously known including Li Lu’s introduction to Charlie Munger at a Thanksgiving dinner in 2003 and Mr. Munger’s subsequent investment:

Mr. Munger says Mr. Li made an immediate impression. The two shared a “suspicion of reported earnings of finance companies,” Mr. Munger says. “We don’t like the bull—.” Mr. Munger gave Mr. Li some of his family’s nest egg to invest to open a “value” fund betting on beaten-down stocks. Two weeks later, Mr. Li says he met again with Mr. Munger to make certain he had heard right. In early 2004, Mr. Li opened a fund, putting in $4 million of his own money and raising an additional $50 million from other investors. Mr. Munger’s family put in $50 million, followed by another $38 million. Part of Mr. Li’s agreement with Mr. Munger was that the fund would be closed to new investors.

We should note that $88 million is not pocket change for Charlie Munger. Forbes estimated Mr. Munger’s net worth at $1.55 billion in last year’s Forbes 400. Given that the $88 million investment was made prior to Mr. Li’s home run with the BYD investment, it is likely that he is now managing far greater sums for Mr. Munger which could represent a substantial portion of his net worth.

Buffett’s Plan for Succession

Warren Buffett declined to directly comment on Li Lu, but was quoted as follows in the Wall Street Journal article:

In an interview, Mr. Buffett declines to comment directly on succession plans. But he doesn’t rule out bringing in an investment manager such as Mr. Li while still at Berkshire’s helm. “I like the idea of bringing on other investment managers while I’m still here,” Mr. Buffett says. He says he doesn’t preclude making a move this year, though he adds that there is no “goal” to bring on an additional manager that quickly either.

The fact that Mr. Buffett is looking for investment managers at Berkshire is not a complete surprise. The subject was first raised in Mr. Buffett’s 2006 letter to shareholders (pdf) which was published in early 2007. Here is an excerpt from the letter in which Mr. Buffett explains his plan:

Under this plan, I intend to hire a younger man or woman with the potential to manage a very large portfolio, who we hope will succeed me as Berkshire’s chief investment officer when the need for someone to do that arises. As part of the selection process, we may in fact take on several candidates. Picking the right person(s) will not be an easy task. It’s not hard, of course, to find smart people, among them individuals who have impressive investment records. But there is far more to successful long term investing than brains and performance that has recently been good.

What Took So Long?

Why did it take more than three years before anyone at Berkshire revealed the identity of a potential investment manager? We cannot know for certain, but it is possible that the severe financial market dislocations in recent years led Mr. Buffett to delay any formal announcement in order to better judge how the investment managers handled the crisis. At the 2009 annual meeting, Mr. Buffett indicated that none of the potential investment managers “covered themselves in glory” during 2008.

We have previously written about Berkshire Hathaway’s succession plans and consider much of the talk about a “Buffett premium” to be unjustified. Warren Buffett cannot be replaced, but he has taken steps to groom a number of potential candidates for the CEO position. Many Berkshire shareholders believe that David Sokol is the front runner to take over as CEO. For the investment management function, there have been more concerns because, unlike the CEO candidates, the investment candidates do not necessarily work for Berkshire currently. With news that Li Lu is a likely candidate, more pieces of the puzzle regarding Berkshire Hathaway in the post-Buffett era are coming into place.

if you really want to learn abt Li Lu and his character, there is an excellent BBC documentary which covers his rise during the Tiananmen demonstrations. It is not a flattering portrayal. This Berkshire shareholder would sell his shares if Mr Lu took any significant role in the company.

Do you have a link to a video or care to provide any specifics? I have yet to read anything negative about Li Lu’s involvement in the demonstrations and believe Buffett and Munger to be excellent judges of character.

There’s a picture of Li Lu here and his face features on other buttons linking to that page from elsewhere, but the link to the 1999 radio programme with phone-in questions doesn’t work. Either deleted or lost in the updates to the BBC web platform over the last 11 years.

Having watched the whole Columbia School of Business talk my Mr. Li, I think he’s very thorough in his analysis (e.g. his Timberland investment) and he’s also very keen to find those rare but extraordinary “inevitables” that can be caught at an early stage maybe 3 times in a lifetime. BYD could well be one of those. He’s also involved with a firm trying to implement the Bloomberg Terminal model for inevitable success for engineers.

The gut is a true value investor with both Ben Graham and Philip Fisher approaches, with plenty of good scuttlebutt to confirm or reject the suspected quality of the investment proposition. Just like Buffett, a large proportion of his 20%+ average annualized returns can be expect to come from single investments that do really exceptionally well (e.g. 100-fold or more growth in the underlying business over 20 or 30 years) and where they’re recognised as inevitable, which is when he’ll make large focused investments. This may also lead to him being underestimated and a good deal of his return being incorrectly attributed to luck.